ICMR Case Collection

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ICFAI Center for Management Research

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Governance Issues at the New York

Stock Exchange

BECG 035

This case was written by K. Subhadra, under the direction of Sanjib Dutta, ICFAI Center for Management
Research (ICMR). It was compiled from published sources, and is intended to be used as a basis for class
discussion rather than to illustrate either effective or in effective handling of a management situation.

2004 ICFAI Center for Management Research. All rights reserved. No part of this publication may be
reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means electronic or mechanical, without permission.
For enquiries regarding bulk purchases and reprint permissions, please call 91-40-23430462/63 or write to ICFAI
Center for Management Research, 49, Nagarjuna Hills, Panjagutta, Hyderabad 500082, India or email
icmr@icfai.org. Copies of this case can also be purchased online from the ICMR website, www.icmrindia.org.

BECG/035

GOVERNANCE ISSUES AT THE NEW YORK STOCK EXCHANGE

The New York Stock Exchange is long overdue for a very serious and thorough examination and
overhaul of its governance. The very fact that they nominate their own board without any input
from anyone else should not be tolerated.
- Nell Minow, Editor, Corporate-Governance Research Firm - The Corporate Library in
August 2003.1

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Today, we take an important step towards a governance architecture with standards of

independence and disclosure that are comparable to or stronger than those we require of our
listed companies.

- John Reed, Interim Chairman & CEO New York Stock Exchange (NYSE) commenting
on the proposed NYSE reforms, in November 2003.2

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PAYBACK TIME AT NYSE

On September 18, 2003, Richard Grasso (Grasso), Chairman and CEO of NYSE resigned amidst
widespread criticism of his pay package and governance practices at NYSE. Earlier in August
2003, NYSE announced that Grasso had been given a lumpsum amount of $140 million from
NYSE (covering two decades of deferred compensation, and retirement benefits). It also
announced that Grassos contract had been extended upto 2007 with an annual pay of $1.4 million,
and an additional $1million annual bonus.

William Donaldson (Donaldson), Chief of the Securities and Exchange Commission (SEC)3,
commented that Grassos compensation details raised serious doubts about governance standards
at the NYSE. Donaldson sent a letter to the compensation committee head Carl McCall (McCall)
asking for more details about how Grassos compensation package had been decided.

NYSE Management, Board Conflicts Criticized By Investors Group, www.securities.stanford.edu, August

1, 2003.

NYSE Outlines Proposals to Strengthen Governance and Names Candidates for New Board of Directors,
Press Release on www.nyse.com, November 5, 2003.

Founded in 1929 by the U.S. Congress to monitor the securities industry and enforce punishments to those
who violate the industry's regulations.
This case was written by K. Subhadra, under the direction of Sanjib Dutta, ICFAI Center for Management
Research (ICMR).

2004, ICFAI Center for Management Research. All rights reserved. No part of this publication may be reproduced, stored in a

retrieval system, used in a spreadsheet, or transmitted in any form or by any means electronic or mechanical, without
permission.

To order copies, call 0091-40-2343-0462/63 or write to ICFAI Center for Management Research, Plot # 49, Nagarjuna
Hills, Hyderabad 500 082, India or email icmr@icfai.org. Website: www.icmrindia.org

Governance Issues at the New York Stock Exchange

The misgovernance at NYSE came to light in August 2003 when the Council of Institutional
Investors (CII)4 published a report which highlighted the shortcomings in NYSEs governance
practices. The Grasso episode provided more ammunition to the critics of NYSE, who were
demanding greater transparency in its working.
In September 2003, former Citigroup Co-CEO, John Reed (Reed) was appointed the new interim
chairman and CEO of NYSE. Soon after taking over the charge, Reed announced that his first
priority would be to reform the working of the exchange. On November 5, 2003, Reed announced
proposed reforms in the governance practices of NYSE. The media, general public and industry
sources welcomed the reforms saying that they were the step in the right direction. However, some
were of opinion that more drastic changes should be brought in to ensure transparency in the
operations of NYSE.

BACKGROUND NOTE

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The history of the NYSE dates back to 1792 when the Buttonwood Agreement was signed by 24
New York-based stockbrokers and merchants. The agreement facilitated trading in securities
between the signatories on a commission basis. In 1817, a formal organization the New York
Stock & Exchange Board (NYS&EB) was formed by brokers; the board also formulated rules and
a constitution for conducting business. By 1824, the NYS&EBs annual trading volume had
reached 380,000 shares and by 1835, the daily trading volume had increased 50-fold to 8,500,000
shares.

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By the 1850s, the NYS&EB had started formulating rules and regulations for listing companies. In
1853, the listing standards were formulated, and these made it mandatory for listed companies to
provide complete information about outstanding shares and capital resources. In the late 1850s and
early 1860s, the NYS&EB witnessed a turbulent period. In 1857, there was a sharp downward
movement in trade due to the collapse of the Ohio Life Insurance & Trust Company. The
NYS&EB registered a 8-10% price decline in a single trading session and by year-end, the decline
stood at 45%. In 1863, the NYS&EB changed its name to the New York Stock Exchange (NYSE).
In the following year, a Committee on Stock List was appointed to oversee the listing of new
securities on the exchange, thus initiating supervision and controlling of listing policies by the
NYSE.
With the increase in trading volume, the NYSE introduced innovative methods for making trading
more convenient. In 1867, for the first time, the stock ticker5 was introduced enabling investors to
know the current prices of the stocks. In 1869, the NYSE abolished watering stocks6 and
introduced a new rule according to which all shares of companies listed on the NYSE had to be
registered with banks or authorized agents.

Founded in 1985, the Council of Institutional Investors with around 130 pension fund members and more
than $2 trillion in assets, seeks to address investment issues that affect the size or security of plan assets. Its
objectives are to encourage member funds, as major shareholders, to take an active role in protecting plan
assets and to help members increase return on their investments as part of their fiduciary obligations.

A telegraphic system that continuously provides the latest sale prices and volume of securities transactions
on exchanges. Information is either printed or displayed on a moving tape after each trade.

Stocks issued in secret before the initial public offering (IPO) are called watering stocks.
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Governance Issues at the New York Stock Exchange

In 1872, the NYSE created the Specialist System (Refer Exhibit I for a note on the Specialist
System). By the mid-1880s, the NYSE had also introduced telephone and paging systems to
increase trading. In 1889, the exchange formed its first subsidiary The New York Quotation
Company, for providing ticker services to its members. In 1892, the New York Stock Exchange
Clearing House was formed to centralize securities transfers between brokers.

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By the end of World War I in 1918, the NYSE had replaced the London Stock Exchange as the
worlds investment capital. Over the next decade, the public issues of around 1,800 foreign
companies had been offered in the US market. In 1920, the NYSE established the Stock Clearing
Corporation to provide a centralized system to enable the delivery and clearance of securities
among members, banks and companies. In 1923, the NYSE witnessed a bull run7, during which
stock prices increased rapidly for the next six years. The bull run came to end in 1929 with the
onset of the Great Depression. The NYSE started restructuring itself in the late 1930s. In 1938, it
hired its first full-time salaried president, and in the following year it opened its first public gallery
enabling the public to witness trading and thus bringing greater transparency in its operations. In
1943, the NYSE started allowing women on the trading floor. Beginning in 1945, there was
another bull run on the NYSE. This continued uninterrupted upto 1953. In 1954, the NYSE
launched its first marketing campaign Own Your Share of American Business with the aim of
educating investors and increasing public participation in the stock market. In the same year, it
also launched a monthly investment plan, which enabled ordinary people to invest around $40 per
month in the market by investing in NYSE members special accounts. In 1961, the average daily
volume on the exchange surpassed 4 million shares and in 1966, NYSEs composite index called
the common stock index was launched.

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In 1968, NYSE faced a paperwork crisis as member firms failed to process the transactions on
time causing delays in stock transfers and payments. The paperwork crisis resulted in the demand
for more automation in the exchange. In the same year, NYSE established the Central Certificate
Service (CCS) for transferring securities electronically. The CCS was succeeded by Depository
Trust Company (DTC) in 1973.

In the mid-1970s, NYSE undertook various steps to upgrade the exchange through new
technology. In 1976, the exchange introduced the fully automated Designated Order Turnaround
(DOT) system, which made possible the routing of selling or purchasing orders electronically. In
1978, NYSE introduced the Intermarket Trading System (ITS), which provided an electronic link
between NYSE and other exchanges, allowing brokers to access all exchanges to find the best
bid/ask price8 for a stock. In the following year, NYSE established a futures9 market known as the
New York Futures Exchange (NYFE) and the same year it began technological upgradation of the
trading floor. In 1984, NYSE launched SuperDot 250 an electronic order routing system linking
member firms and specialist posts on the trading floor.
In 1993, NYSE announced an Integrated Technology Plan (ITP) to upgrade trading floor networks
(hardware and software). This increased handling capacity to 1 billion shares a day. The
implementation of the ITP was completed in 1995, and in the same year NYSE shifted to a three7

During a bull run, the prices of stocks keep increasing. A bull run denotes optimism in the market.

The bid price is the price at which an investor, trader, or dealer wants to buy a security. The ask price is the
price at which an investor, trader or dealer wants to sell a security.

A contract specifying the future date of delivery or receipt of a certain amount of a specific tangible or
intangible product. The commodities traded in futures markets include stock index futures; agricultural
products like wheat, soybeans and pork bellies; metals; and financial instruments. Futures are used by
business as a hedge against unfavorable price changes, and by speculators who hope to profit from such
changes.
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Governance Issues at the New York Stock Exchange

day settlement period10 for listed equities. In the same year, Grasso was elected as chairman of the
exchange. In 1996, NYSE launched its first real-time ticker on the CNBC and CNN-FN channels,
and in the following year, it also started a wireless data system which allowed brokers to receive
and execute orders from anywhere on the trading floor.
During the late 1990s, NYSE focused on upgrading technology because of increasing criticism of
its outdated technology compared to NASDAQs.11 In 1999, the exchange had established a 3-D
trading floor using up-to date technological systems such as plasma monitors and silicon graphics
workstations to provide market information to the brokers. In 2000, NYSE shifted to decimal
trading12 and in the same year it announced plans for a NYSE Platform network comprising NYSE
Direct+13, NYSE MarkeTrac14, NYSE OpenBook15, Institutional XPress16, and NYSE e-Broker17.

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The early 2000s saw investor confidence in stock markets plummeting due to the dotcom bust.
Investor confidence took a further beating after terrorist attacks in the US18, after which NYSE was
closed for five days. In 2002, NYSE reported an average daily trading volume of 1.44 billion
shares and annual revenues of $1.065 billion. The total number of listed companies on the
exchange was 2,783. In mid-2003, NYSE was facing a lot of flak for its governance practices.
Investors were additionally aggrieved to learn the size of Grassos compensation package.

The date by which an executed securities transaction must be settled, by paying for a purchase or by
delivering a sold asset; usually three business days after the trade was executed (T+3); or one day for
listed options and government securities.

11

National Association of Securities Dealers Automated Quotation (NASDAQ) is an automatic information

network that provides brokers and dealers with price quotations on securities traded over-the-counter.

12

In decimal trading the quotation and trading of stock or bond prices are stated in decimals, as opposed to
quotation in fractions.

13

An automatic-execution service for limit orders up to 1,099 shares, which enables users to opt for an
immediate execution at the best bid or offer.

14

An online investor tool providing a 3-D connection to the point of sale, bringing individual investors
closer to the trading floor and creating additional transparency in trading. Features include a virtual
representation of the trading floor with news, an activity map and historical price charts; customizable
portfolio and index tracking; and detailed quote views and performance graphs.

15

An information tool that offers a real-time view of the exchange's limit-order book for all NYSE-traded
securities. Traders can see aggregate limit-order volume at every bid and offer price.

16

An electronic gateway designed specifically for the needs of NYSE member firms and their institutional
customers.

17

A wireless handheld order-management tool facilitating seamless connectivity between floor brokers and
off-floor locations by organizing orders, tracking executions, and speeding the flow of information. Using
market looks, a broker can provide his or her customer with current quotes, crowd participation, and
other market insights directly from the point of sale.

18

On September 11, 2001, terrorists had attacked the US through airplane crashes on the twin towers of the
World Trade Center and the Pentagon.

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Governance Issues at the New York Stock Exchange

THE WORKING OF NYSE

NYSE is defined as a member-owned co-operative and self-regulatory organization that serves
the public as the nations principal securities market, its principal self-regulator and its principal
source of governance standards.19 It comprises of three constituencies, viz., broker-dealer
members, listed companies and the investing public. The specialist firms and floor brokers are
grouped under broker-dealer members. The specialist firms employ specialists involved in the
trading of stocks of particular companies.
At NYSE, trading takes place at one central location the trading floor (Refer Figure I) where
both buyers and sellers compete to get best price for their clients. Usually, each stock is assigned a
trading post, with specialists managing the auction process.

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FIGURE I
TRADING FLOOR

A - Post information display provides market information to specialist.

B - Flat panel display screen, which enables brokers to know prices of each stock.
C - Point of Sale Display Book enables specialist to handle volumes.
D, E Brokers who execute customer buy/sell orders.
F - Specialist- order book for which the specialist has agency responsibility, assists in the
recording and dissemination of trades and quotation changes, and facilitates the research of
orders.
G - Specialist trading assistant working at point-of-sale workstation.
H, I - New York Stock Exchange Wireless Data System (WDS) transfers information to
and from point-of-sale. Brokers were provided with an advance Hand Held Device (HHD)
enabling them to receive orders electronically.
Source: www.nyse.com

NYSE has the authority to regulate securities firms dealing with public accounts in the US. The
Enforcement Division oversees the working of listed companies. It is given powers to take
19

www.nyse.com
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Governance Issues at the New York Stock Exchange

disciplinary actions against firms violating the listing and disclosure rules of the exchange as well
as ensuring the transparent working of the listed companies. NYSE also oversees the working of
broker-dealer members to ensure a free and fair market.

GOVERNANCE STRUCTURE AT NYSE (Pre-reform)

NYSEs governance structure comprised five important elements: the Board of Directors (BoD),
standing and advisory committees, a nominating committee, its professional executive
management, and its not-for-profit status.

BoD and Standing and Advisory committees

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The 1,366 broker-dealer members of the exchange elected the BoD which consisted of 27
members (12 industry directors, 12 non-industry directors and 3 members of the office of the
chairman)20. (Refer Table I) No director was allowed to be on the board for more than three
consecutive two-year terms. The NYSE constitution defined an industry director as (1) an
individual member, (2) an individual who is a principal executive, general partner or control
person of a member organization, or (3) a principal executive of an organization whose principal
subsidiary is a member organization.21 Non-industry directors did not belong to the securities
industry. The day-to-day working of the exchange was overseen by the board. The board played an
active role in formulating policies and programs governing the working of the exchange. Further
NYSE constituted various standing and advisory committees which were comprised of NYSE
directors, to regulate the functioning of NYSE. The exchange had five standing committees, ten
advisory committees and four international advisory committees (Refer Exhibit II).

20

21

12 industry directors were elected from the securities industry and 12 non-industry directors from the non
securities industry representing public.
White Paper on Governance, www.nyse.com
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Governance Issues at the New York Stock Exchange

TABLE I
COMPOSITION OF THE BOARD (2002) **
DIRECTOR NAME

CATEGORY

PROFILE

Richard A. Grasso*
Robert G. Britz*

Catherine R. Kinney*

Non-Industry Director

William B.Harrison, Jr.

Non-Industry Director

Carol Bartz

Non-Industry Director

James E. Cayne

Industry Director

Mel Karmazin

Non-Industry Director

Kenneth G. Langone

Industry Director

James M. Duryea
Peter N. Larson

Industry Director
Non-Industry Director

Gerald M. Levin
John J. Mack
Joseph A. Mahoney

Non-Industry Director
Industry Director
Industry Director

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Non-Industry Director

Leon E. Panetta

Laurence D. Fink

Chairman & CEO, NYSE

Executive Vice Chairman, President
and Co-Chief Operating Officer,
NYSE.
Executive Vice Chairman, President
and Co-Chief Operating Officer,
NYSE.
Chairman and Chief Executive Officer,
BlackRock, Inc.
Chairman and Chief Executive Officer,
J.P.Morgan Chase & Co.
Chairman of the Board, Chief
Executive Officer and President
Autodesk, Inc.
Chairman and Chief Executive Officer
The Bear Stearns Companies Inc.
President & Chief Operation Officer,
Viacom Inc.
Chairman of the Board, Invemed
Associates LLC
President, J. M. Duryea Inc.
Chairman and CEO (Retired) Brunswick Corporation
CEO (Retired) AOL Time Warner Inc.
CEO, Credit Suisse First Boston
Senior Managing Director and Chief
Administrative Officer - Bear Wagner
Specialists LLC
Director - Panetta Institute for Public
Policy
Chairman and CEO - The Goldman
Sachs Group, Inc.
CEO - Fleet Specialist, Inc.
Chairman of the Board of Management
DaimlerChrysler AG
Chairman and CEO - Wilson Sonsini
Goodrich & Rosati
Chairman, McDonald Investments
New York State Comptroller (Former)
Chairman, First Albany Companies Inc
Chairman of the Board Merrill Lynch
& Co., Inc
Vice Chairman & CEO LaBranche &
Co., LLC

Industry Director

Christopher C. Quick
Juergen E. Schrempp

Industry Director
Non-Industry Director

Larry W. Sonsini

Non-Industry Director

William B. Summers, Jr.

H. Carl McCall
George C. McNamee
David H. Komansky*

Industry Director
Non-Industry Director
Industry Director
Industry Director

Robert M. Murphy*

Industry Director

Henry M. Paulson, Jr.

Source: NYSE Annual Report, 2002

* Members of the Office of the Chairman

** This list is not exhaustive

Governance Issues at the New York Stock Exchange

Nominating Committee
The nominating committee consisted of eight members - four from the industry category and four
from the non-industry category. The members of the nominating committee were elected for two
years, and no member could be re-elected for the second consecutive term. The nominating
committee nominated members to be elected to the BoD.
Professional Management
Though till the 1970s, the members of the exchange oversaw the day-to-day functioning of the
exchange; from the early 1970s, a professional management team was appointed by the Chairman
and CEO with the approval from the board to oversee administrative matters. But the executive
vice-president of the exchange was directly elected by the board.
Not-for-Profit Status

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Initially NYSE was formed as a membership organization, and in 1971, it was incorporated under
the Not-for-profit Corporation Act. The main aim of the exchange was stated to be maximizing
the reliability and integrity of market functioning, rather than to maximizing profits.

NYSE COMES UNDER FLAK

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Over the years, the style of governance at NYSE has attracted a lot of criticism chiefly on account
of misgovernance and the role of specialists. Analysts pointed out that the governance structure
at NYSE had failed to deliver results, and that the NYSE had failed to safeguard the interests of
the general public. However, finally, it was the controversy over its CEOs compensation that
resulted in the eruption of the wrath of the media and the general public.

COMPOSITION OF THE BOARD

Analysts said that while NYSE demanded greater transparency in the operations of the companies
it regulated, it did not itself maintain any transparency in its own working processes. The process
of electing the NYSE board was not transparent and, in fact, the board was handpicked by the
Chairman. Though the exchange claimed that its election process was fair and transparent, analysts
pointed out that the candidates to be elected to the board were nominated by the nominating
committee, which itself was regulated by the Chairman and the board members themselves.
In early 2003, as criticism of the system at the stock markets in the US mounted, SEC Chairman
Donaldson asked all the exchanges and their regulatory bodies in the US to review their
governance processes. At this point, NYSE requested the CII to prepare a report on the governance
practices at NYSE. In August 2003, the CII submitted a very critical 47-page report on the
governance practices at NYSE. In its report, the CII said, The exchange's public purpose is to
protect investors - but it is owned and operated by a profession that has its own needs to tend to.
The big banks - the so-called broker-dealers - are not the only groups with interests to be
considered, yet they wield massive influence over the NYSE.22

22

English, Simon, Wall Street report slams 'cosy' NYSE, www.telegraphic.co.uk, August 8, 2003.

Governance Issues at the New York Stock Exchange

The CII reported that the directors on the board were too busy to devote the required time to
regulatory matters. Most of the directors were top executives of companies and they had their own
businesses to look after. The CII report stated, Board members have too many connections among
themselves to be effective.23 For instance, Grasso was inducted into the board of Home Depot,
while Home Depots co-founder Ken Langone was a director at the NYSE.

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Analysts felt that conflict of interests in the roles played by the members of the BoD was one of
the main reasons for misgovernance at the NYSE. The role of the directors was to maintain a free
and fair market environment and to ensure high standards of working to safeguard the interests of
the public. But, this did not happen. There was a primary conflict of interest between the role
played by members of the BoD in their capacity as members of the board and their role as CEOs or
important officials in their primary businesses. Half of the directors who represented the board did
business on the exchange, and the other half had companies listed on the exchange or had a close
relationship with listed companies. Commenting on the role of non-industry directors, Fortune
wrote, But these people dont wake up each morning wondering how they can protect investors
they wake up thinking about how to make money for their companies, a noble goal to be sure, but
not exactly the watchdog role the securities market might like.24 Of the role conflict, Robert
Mittelstaedt, vice dean and director executive education, Wharton School of Business, said,
They are fundamentally different activities. You cant be both a regulator and an organization that
is trying to draw companies [as members] and make it attractive for them to function on the
exchange.25

THE ROLE OF SPECIALISTS

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The specialist system at the NYSE also attracted considerable criticism. In April 2003, the SEC
initiated an investigation against trading violations committed by specialists. The specialists were
alleged to be involved in front running26. However, the NYSE refuted the charges and announced
that SEC was inquiring into violation of the negative-obligation rule27. But analysts pointed out
that the objective of the inquiry remained the same, though the rules violated differed. The primary
question which the NYSE needed to answer was whether its specialists purchased shares at lower
price with an intention to sell them afterwards for profit. The firms which faced investigation
included Spear, Leeds & Kellogg (a subsidiary of Goldman Sachs), Fleet Boston Financial, Bear
Wagner (partly owned by Bear Stearns), LaBranche and Van der Moolen.

This was not the first time the specialist system had come under scrutiny. In 1999, NYSE entered
into a settlement with the SEC to make the specialist system more transparent.28 However, with
fresh allegations against specialists surfacing again in 2003, analysts felt that not much had been
done to bring transparency into the system. In the early 2000s, when businesses were reeling under
23

English, Simon, Wall Street report slams 'cosy' NYSE, www.telegraphic.co.uk, August 8, 2003.

24

Lashinsky, Adam, NYSE: Whos Minding the Store? Fortune, March 24, 2003.

25

How to Restore Credibility at the NYSE, www.knowledge.wharton.upenn.edu, September 24, 2003

26

An illegal activity in which a trader takes a position in an equity in advance of an action which he/she
knows his/her brokerage will take that will move the equity's price in a predictable fashion.

27

The negative obligation ensures that specialists do not get involved in the market on their own behalf
when the market is able to "make itself" and sufficiently match buyers with sellers. This obligation on the
specialists provides the public an opportunity to transact with one another without the intervention of the
specialists.

28

The SEC was investigating the charges of violations by specialists way back in early 1990s. As a result of
SEC investigation, one floor broker was banned from the securities industry.
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Governance Issues at the New York Stock Exchange

pressure due to a slowdown, specialist firms at NYSE posted pre-tax profit margins of 35-37%
against the 9.7% margin of corporate America as a whole. This raised questions about the working
methods of specialists. Many felt that specialists took unfair advantage of their exclusive
knowledge of investor orders.
Analysts were also critical about execution of orders at NYSE. Investors could not execute their
buy/sell orders immediately as they were required to go through specialists or floor brokers paying
high commissions.

THE FINAL ASSAULT- CEO COMPENSATION

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Finally, NYSE also faced increased criticism because it did not reveal its executive compensation
figures. Under increasing pressure from the media and SEC, the NYSE announced its executive
compensation figures in August 2003. These figures indicated that Grasso had been paid a
lumpsum amount of $140 million for his services and that his employment contract had been
extended upto the year 2007. The exchange revealed that Grasso would be receiving around $1.4
million as salary per year and a bonus of $1 million per year in the period 2003 to 2007. In
addition, Grasso was entitled to receive around $48 million in the future as benefits.

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Grassos pay package attracted criticism from all quarters. Under pressure, Grasso announced that
he would not take the $48 million. Grassos pay package was publicly criticized by Donaldson.
Donaldson issued a statement saying that Grassos pay package raised doubts about the NYSE
administration and asked NYSE to submit the minutes of the meetings in which Grassos
compensation had been finalized. Meanwhile, the Washington Post29 reported that members of the
executive compensation committee were appointed by Grasso himself. The composition of the
compensation committee was thus under public scrutiny too. It was apparent that the compensation
committee comprised of executives from companies which were regulated by the NYSE. Further
as Fortune reported, one of the NYSE directors had claimed in an email that board members who
were not in the compensation committee, did not know about the break-up of Grassos pay
package.30

Refuting the allegations that the compensation package was not properly drawn up, NYSE said
that it acted on the advice of HR consultants. It said that it had taken advice from Hewitt
Associates31 regarding Grassos compensation and that it had hired an independent consultant
Vedder Price32 to assess the CEOs compensation. Independent analysts however felt that Grassos
pay package should have been more in line with the salary drawn by the chief of SEC who earned
around $142,500 per annum. But some felt that there was nothing wrong in the NYSE chief being
compensated on par with top financial services industry executives. However, analysts considered
Grassos pay package high even when compared to industry salaries.
Even NYSE insiders criticized Grassos compensation deal. The members of the exchange were
furious that while the operating income and volume of trade on the exchange were declining,
Grasso had rewarded himself so handsomely. It was reported that the cost of operating on NYSE
29

Leading US news paper.

30

Tully, Shawn, See Dick Squirm, Fortune, September 15, 2003.

31

Established in 1940, Hewitt Associates is a global outsourcing and consulting firm delivering a wide range
of human capital management services.

32

Founded in 1952, Vedder, Price, Kaufman & Kammholz is a law firm. The firm advises organizations on
corporate responsibility and other related matters.
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Governance Issues at the New York Stock Exchange

had increased by over 30% during 2000-2003. Public resentment against Grasso increased further
as two large pension funds in the US demanded his resignation. Under the unrelenting pressure,
Grasso resigned in September 2003.

THE CLEAN-UP EXERCISE

Reed who took over as the interim chairman and CEO of NYSE in October 2003 initiated reforms
at the exchange. He conducted interviews with the specialists, outside critics and experts on the
kind of reforms to be initiated in the exchange procedures. Many suggested that NYSE should go
the NASDAQ way by separating the regulatory function.33 Further, it was also suggested that the
specialist system should be done away with, and the NYSE should opt for electronic trading.

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However, to the disappointment of many, Reed announced that he intended to keep the specialist
system and would be focusing only on restructuring the NYSE board and bringing more
transparency into the decision-making process of the exchange. Defending the specialist system at
NYSE, Reed said, Computer systems find liquidity but they dont add any liquidity. The
specialist system brings capital into the system. All the studies suggest this is helpful.34 Though
he agreed that the specialist system delayed the speed of transactions, Reed was of the opinion that
reviewing the whole trading system would not be very easy.

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On November 5 2003, Reed announced his proposed reforms in the methods of governance at the
NYSE. It was proposed that the board would have independent directors with the responsibility of
supervising regulation, governance, compensation and internal administration. Reed also
announced that the BoD would be appointing an executive board (BOE) comprising of
representatives from broker/dealer members, listed companies and the general public. Further, it
was stated that BOE would meet regularly to discuss issues related to marketplace operations,
membership, listed companies, market structure and performance. The exchange would also have a
Chief Regulatory Officer who would be appointed by the board of directors and he would report to
the Regulatory Oversight Committee (Refer Table I for details on the BOD and BOE).

33

After various scandals rocked NASDAQ in the mid-1990s, NASDAQ separated its regulatory function to
totally independent body NASD.

34

Liston, Broward, NYSEs Reed to Keep Specialist Trading, www.washingtonpost.com, November 4, 2003.

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Governance Issues at the New York Stock Exchange

TABLE I
PARTICULARS
Responsibilities

WORKING OF BOD & BOE (Post-reform)

BOD
Board would act as a trustee.
BOD would be answerable to the
members and SEC.
It would comprise of 6-12 directors
excluding current CEOs of member
organizations and listed companies, the
NYSE chairman and CEO.

Composition

The BOD would meet at least quarterly

and it would also have joint meetings
with BOE.

Standing Committees

Under the new governance system, the

BOD would constitute the following
standing committees:
Audit Committee: This committee
would be set the internal audit
budget.
Regulatory Oversight Committee:
This would set the budget for all
regulatory functions.
Regulation, Enforcement & Listing
Standards Committee: This would
oversee the regulatory group, hearing
board, arbitration and Listings and
Compliance Unit, and act as Court
of Appeals in case of disciplinary
and delisting hearings.
Quality of Markets/Public Policy
Committee: This would act as an
advisory on the issues related to
member organizations and listing
rules.
This committee would report to the
BOD.

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Meetings

BOE

Basically it would be an advisory

body giving guidance on the
working of the exchange.
It would consist of members from
Institutional
Investors/
CEOs/CIOs of public funds,
CEOs of listed companies, lessor
members35, CEOs of specialist
firms, floor brokers, the NYSE
Chair and CEO.
It would meet at least 6 times a
year. The lessor and floor
members would be meet the BOD
separately.
Under the new system, the BOE
would constitute the following
standing committees:
Market Performance: This
committee would serve as
forum to discuss issues related
to
trading
and
market
operations and develop trading
rules and products.
Allocation: This would oversee
the allocation of stocks to
specialists.

Advisory Committee
Source: www.nyse.com

Under the proposed reforms, the 27-member board of NYSE would be reduced to 6-12 directors. It
was also reported that none of the directors would be from the securities industry or from the listed
companies on NYSE. However, it was stated that executives from the securities industry would
serve in advisory committees of the exchange (Refer Exhibit III for the proposed governance
architecture of NYSE).
The proposed changes met with mixed reactions. While SEC reacted positively saying that the
proposed reforms were a step in the right direction, the USs largest pension fund California Public
Employees Retirement System Board (Calpers) said that the proposed reforms were not enough to
regain investor confidence, and asked SEC to reject the proposals. Sean Harrigan (Harrigan),
35

Lessors are the ones who own right to trade on the NYSE, but lease them to the trade brokers.
13

Governance Issues at the New York Stock Exchange

President Calpers, said, Our proposal at this point in time is just that the proposed governance
model that Mr. Reed has put forth be rejected by the Securities and Exchange Commission. Self
regulation, in my opinion is highly risky and simply will not work.36 Harrigan was of the opinion
that the new proposals would not bring in any changes in the governance system of the NYSE but
was just shuffling the chairs.

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Some were of the opinion that, though Reed was expected to bring in drastic changes in the NYSE
working by abolishing the specialist system, he did not favor this as it would be difficult to get the
approval of the exchange members when it came up for voting. They felt that since he was an
interim Chairman and CEO of the exchange, Reed had concentrated only on the board structure
and governance practices, rather than on the tricky issues such as the working of the specialist
system. It was felt that by adopting a moderate approach, Reed had gained the support of the floor
members. The proposed reforms of the NYSE were put to vote on November 18, 2003 and gained
the acceptance of the members of the exchange. In December 2003, however, Calpers filed a suit
against NYSE and specialist trading firms in the US District Court, Southern District of New
York, alleging fraud and negligence in regulatory functioning resulting in high costs for investors.
It was alleged that specialists, in conjunction with the NYSE routinely engaged in wide-ranging
manipulative, self-dealing, deceptive and misleading conduct that hurt public investors seeking to
trade stocks.37

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QUESTIONS FOR DISCUSSION:

The most important question that still remains is how far the reforms initiated by Reed will ensure
transparency in the working of the board. And more importantly whether the new board will be
able to bring greater credibility to the exchange.

1. Analyze the working and corporate governance set up at NYSE and comment on the same. Do
you agree that NYSE failed to meet the expectations of investors in regard to governance
practices?

2. Some analysts were of the opinion that controversy regarding Grassos compensation was one
of the main reasons for the overhauling of the NYSE governance system. Analyze the impact
of the controversy over Grassos compensation, on NYSE and its reputation.
3. Though most brokers and investors had a positive reaction to the reforms bought in by the
exchanges interim CEO John Reed, a majority also felt that more had to be done to bring in
greater transparency. Do you think the reforms suggested by John Reed are enough or does
more need to be done? Justify your answer.

36

Calpers: NYSE Proposal Not Good Enough, www.money.cnn.com, November 6, 2003.

37

Calpers sues NYSE, alleges fraud, The Economic Times, December 18, 2003
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Governance Issues at the New York Stock Exchange

EXHIBIT I
A NOTE ON SPECIALISTS
The specialist system is unique to the NYSE system. There are around 443 specialists operating on the floor
of NYSE, trading shares of around 2,800 companies listed on the exchange. These specialists work for the
seven specialist trading firms registered with NYSE, and each specialist trading firm is allotted specific
company stocks. Specialists undertake equity trading across various industries, and generally a specialist
manages between five to ten stocks.
The main responsibility of the specialists is to act as a contact point between buyers and sellers and to
maintain a free and fair environment in the market. It is the specialists duty to ensure that each and every
customer order gets a fair opportunity while trading to get the best price. Further, a specialist also ensures that
there are no huge price variations in the stock between every trading session. Generally auctions are
conducted at specialists posts, considered as a point of sale. In order to perform the above duties, every
specialist plays four vital roles: - that of an Auctioneer, an Agent, a Catalyst, and a Principal. The four roles
of specialist are explained below.
Auctioneer: As an auctioneer the main duty of the specialist is to provide the best ask and bid prices
throughout a day. Ask and bid prices provided by specialists are transmitted across the world by market
data systems instantly. It is the responsibility of a specialist to reflect the true market conditions through
his quotes. He also interacts with the floor brokers and sees that order is maintained in the market.

Catalyst: The specialist in the role of a catalyst tries to maintain the flow of orders. He keeps track of
buyers interested in his specialized stock and informs them when someone places an order to sell stock.
He interacts with the various parties bringing in sell and purchase orders and tries for price
improvement38 to see that everyone gets the best price.

Agent: In the role of agent, a specialist is responsible for all electronically-routed orders. Sometimes a
floor broker might leave the order with specialist for execution at a specified price. As an agent, the
specialist should strive to hold the interests of his clients above his personal interest irrespective of
order size. Commenting on the specialists role as an agent, a specialist with LaBranche said, The
price should always reflect the supply and demand entrusted to you and represented in the trading
crowd at a particular time. It is our job to pair off the orders and deal with imbalance. Whether its an
order for 100 shares or 100,000, each is just as important.39

Principal: In his role as a principal, the specialist sometimes even provides capital to improve the
liquidity of the market. A specialist does not provide huge capital for the market or determine the prices
of the stocks; he steps in to provide capital only when there is a wide price fluctuation in the market due
to gaps in the demand and supply of stocks. By providing capital to bridge the fluctuations in the
market, specialists play an important role in reducing the price volatility in the markets. In order to
maintain order in the market, a specialist buys or sells the stock with him adjusting the price movement.
When price of the stock is increasing he sells the stock with him and when price is declining he creates
a demand by buying the stock.

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From the above, it can be seen that the roles of the specialist as principal and agent are quite critical.
Analysts feel that both roles provide ample opportunity for specialists to manipulate the price movement of
stocks and gain personally. To ensure that specialists are not exploiting their privileges, their performance is
monitored by the NYSE Market Surveillance Division through advanced analysis and technology.
Adapted from the article Inside the NYSE: The Specialist, NYSE Magazine, March 7, 2003 and www.psgllc.com

38

When a buy order is executed at a price lower than the current quoted offer, or when a sell order is
executed at a price higher than the current quoted bid. In addition to quoting the best prices more than 90
percent of the time, the NYSE continuous auction market typically improves upon these quoted prices,
allowing investors to get a better price for their shares.

39

Inside the NYSE: The Specialist, NYSE Magazine, March 7, 2003.

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Governance Issues at the New York Stock Exchange

EXHIBIT II
NYSE COMMITTEES

Makes recommendations to the board on proposed rule

changes.
Oversees the finance and audit matters of the exchange.
Makes recommendations to the board on the
compensation of board members and also oversees the HR
issues of the exchange.
Hears appeals about disciplinary delisting decisions.

Advises on matters relating to individual investors. The

committee advises on policies to enhance the interests of
individuals investing in equities, options, futures and
fixed-income securities. Also focuses on enhancing
communications between individual shareholders and the
NYSE board.
Advises on the impact of proposed trading rules and
related developments on institutional investors. Also
focuses on improving communications between the
Exchange and institutional investors.
Advises NYSE board on the impact of proposed rules on
pension funds. Also strives to improve communications
between pension managers and the NYSE.
Advises board on policy-related matters involving listed
companies and the impact of rules and regulations on
them.
Advises on legal and corporate governance matters that
affect the NYSE, the securities industry or the US capital
markets. The committee assists the NYSE staff on all
corporate governance projects, regulation of the financial
services industry, and legal matters relating to industry
rules and regulations.
Advises on the impact of proposed rules on the NYSE
specialty firms. It also acts as a communication channel
between board and specialty firms by conveying their
problems to the board.
Advises on the matters relating to NYSE regional member
firms. It also acts as an avenue through which regional
firms convey their problems to the board.
Advises the board on the regulatory system including the
self-regulation of the board.

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Institutional Traders
Advisory
Committee

FUNCTION

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Advisory
Committees

COMMITTEE
NAME
Public Policy
Committee
Quality of Markets
Committee
Finance & Audit
Committee
Human Resources
& Policy and
Compensation
Committee
Committee for
Review
Individual Investors
Advisory
Committee

COMMITTEE
TYPE
Standing
Committees

Pension Managers
Advisory
Committee
Listed Company
Advisory
Committee
Legal Advisory
Committee

New York Area

Firms Advisory
Committee
Regional Firms
Advisory
Committee
Regulatory
Advisory
Committee
Upstairs Traders
Advisory
Committee

Advises on matters relating to increasing the efficiency of

the NYSE marketplace. It also focuses on improving
communication between the trading floor and trading
desks.

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Governance Issues at the New York Stock Exchange

Asia Pacific
Advisory
Committee
European Advisory
Committee

International
Advisory
Committees

International Capital
Markets Advisory
Committee

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Latin America
Advisory
Committee

It advises on matters relating to exchange markets and on

ways to strengthen their operations. The committee also
advises on the impact of proposed trading rules and other
matters related to Exchange traders, and facilitates
communication between the NYSE and traders.
Advises on issues related to international capital markets
and the concerns of business and financial communities of
the represented countries.
Advises the board on the views of European corporates on
the role of the NYSE in international matters. Further it
also focuses on the ways to strengthen communications
between the NYSE and the European corporate
community.
Provides feedback to the NYSE about its policies and
programs in the international area, advises the Exchange
on operating systems, and recommends programs to
encourage foreign companies to list their securities in the
US.
Provides the board with the representative views and
attitudes of the Latin American corporate community on
the role of the NYSE in international matters. Advises on
areas including: strengthening Exchange policies and
programs dealing with the internationalization of the
capital markets; facilitating multinational offerings of
corporate securities; monitoring legislative and regulatory
proposals that impose duties or responsibilities on
corporate boards of publicly owned issuers; and
strengthening communications between the Exchange and
the Latin American corporate community.

Exchange Traders
Advisory
Committee

Source: www.nyse.com

17

Governance Issues at the New York Stock Exchange

EXHIBIT III
PROPOSED CORPORATE GOVERNANCE ARCHITECTURE OF NYSE

Nominating
&
Governance
Committee

Market
Structure &
Strategy
Committee

Quality of
Markets/Public
Policy
Committee

op

Human
Resources &
Compensation
Committee

Board of Executives (BOE)

Representative Constituent
Body
BOD Appoints BOE

Board of Directors (BOD)

Independent Directors
BOD Elects Chair

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Audit
Committee

Finance Committee

Regulatory
Oversight &
Regulatory Budget
Committee

Regulation,
Enforcement &
Listing Standards
Committee

Market
Performance
Committee

Source: www.nyse.com

18

Allocation
Committee

Governance Issues at the New York Stock Exchange

ADDITIONAL REFERENCES & READINGS:

23.
24.
25.
26.
27.
28.
29.
30.
31.
32.
33.
34.
35.
36.

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11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.

10.

9.

Regulate Thyself, The Economist, October 10, 2002.

Patsuris, Penelope, Who Polices the Police?, Forbes, October 16, 2002.
Inside the NYSE: The Specialist, NYSE magazine, March 7, 2003.
Lashinsky, Adam, NYSE: Whos Minding the Store?, Fortune, March 24, 2003
Specialist Help Needed, The Economist, April 24, 2003.
Ackman, Dan, Dick Grasso and the Company He Keeps, Forbes, May 7, 2003.
The Shakedown Continues, The Economist, June 27, 2003.
NYSE
Management,
Board
Conflicts
Criticized
By
Investors
Group,
www.securities.standford.edu, August 1, 2003.
English, Simon, Wall Street Report Slams 'Cosy' NYSE, www.telegraph.co.uk, August 4,
2003.
NYSE Owners Say Exchange's Governance Rules Leave Them Out,
www.quote.bloomberg.com, August 5, 2003.
Birnbaum, Jeffrey H., An SEC Chief with Teeth?, Fortune, August 11, 2003.
Plus a Change, The Economist, August 14, 2003.
Tully Shawn, Saving Money the NYSE Way, Fortune, September 2, 2003.
Grasso's Gross-Out, The Economist, September 6, 2003.
Weiss, Gary, THE $140,000,000 MAN, BusinessWeek, September 15, 2003.
Tully, Shawn, See Dick Squirm, Fortune, September 15, 2003.
Serwer, Andy, Dick Grasso Is Out, Fortune, September 17, 2003.
Lashinsky, Adam, How the NYSE Needs to Change, Fortune, September 18, 2003.
Grasso Goes, The Economist, September 19, 2003.
Taking Stock of Dick Grasso, The Economist, September 20, 2003.
The Bell Tolls for Grasso, The Economist, September 20, 2003.
NYSE Reforms Panel Has Close Ties to Grasso, www.business-times.asia1.com, September
20, 2003.
Farrell, Greg, Critics Take Aim at NYSE 'Specialists', www.usatoday.com September 22,
2003.
Stone, Amey, The NYSE's New Broom, BusinessWeek, September 23, 2003.
How to Restore Credibility at the NYSE, www.knowledge.wharton.upenn.edu, September
24, 2003.
Lessons from the Grasso Affair, BusinessWeek, September 29, 2003.
Tully, Shaw, Reed to NYSE: Get Ready For Reform, Fortune, September 30, 2003.
Weiss, Gary; Dwyer, Paul & Borrus, Amy, New Broom at the Big Board, BusinessWeek,
October 6, 2003.
Mandel J., Michael, Commentary: Reform the Exchange Gingerly, BusinessWeek,
October 6, 2003.
Kuttner, Robert, The Big Board: Crying Out for Regulation, BusinessWeek, October 13,
2003.
Goto, Shihoko, NYSE Reforms Must Come From Within, www.washingtonpost.com,
October 15, 2003.
Weiss, Gary, This Blow May Bolster the Big Board, BusinessWeek, October 16, 2003.
Tully, Shawn, Bringing Down the Temple, Fortune, October 26, 2003.
Liston, Broward, NYSE's Reed to Keep Specialist Trading, www.washingtonpost.com,
November 4, 2003.
NYSE Outlines Proposals to Strengthen Governance and Names Candidates for New
Board of Directors, www.nyse.com, November 5, 2003.
Reeds Rejig, The Economist, November 6, 2003.

1.
2.
3.
4.
5.
6.
7.
8.

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Governance Issues at the New York Stock Exchange

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37. Calpers: NYSE Proposal Not Good Enough, www.money.cnn.com, November 6, 2003.
38. Weiss, Gary; Weber, Joseph & Arner, Faith, Commentary: NYSE: How Deep Will Reform
Run?, BusinessWeek, November 10, 2003.
39. What the NYSE Needs Now, BusinessWeek Editorial, November 17, 2003.
40. Weiss, Gary; Borrus, Amy & Arner, Faith, Too Little, Too Late, Mr. Reed?, BusinessWeek,
November 17, 2003.
41. www.nyse.com

20